Management 205a - International Economics

101.1

© Daniel J.B. Mitchell (See cover page for details.)

Strategic Trade Policy

The Ricardian analysis of international trade suggested that the
gains from trade came from technological differences i.e.,
international differences in productivities. It assumed constant
returns to scale and a perfectly competitive economy. The 2-factor
model and the related Heckscher-Ohlin analysis suggested that the
gains from trade stemmed from international differences in factor
endowments again under the assumption of perfect competition and
constant returns to scale.

In Section 17, we have already noted that assuming increasing
returns to scale (diminishing average and marginal costs, economies
of scale) can change the analysis. We noted there, for examples that
two countries might have gains from trade based on exploiting
increasing returns . Left unsaid at that point was that industries with
economies of scale in the relevant range are unlikely to be purely
competitive. This is because there is an advantage to the firm that
increases its share of the market the most. It experiences the
greatest reduction in costs (and therefore a cost advantage relative
to smaller competitors) . If an industry ends up with one (or a few)
big firms, it won't be perfectly competitive. Rather, it will be
monopolistic or oligopolistic.

There are gains for a country to exploit if it can dominate an
industry and thereby extract a monopolistic rent from consumers in
other countries. The world as a whole may not be better off in such
a case (although it might benefit from exploitation of economies from
scale) , but the country whose producer (s) receive (s) these rents may
be better off. Hence, there is a potential role for what has been
termed "strategic trade policies," i.e., national policies of trade
restriction and/or subsidy to enable non-competitive industries to
obtain monopoly rents .

To some extent, the arguments that countries should follow
"industrial policies" which favor certain industries fall into this
category. Some of the arguments for preventing other countries from
predatory dumping or subsidizing their exports also can be
rationalized on these grounds. The importing country may fear
eventually being forced to pay monopoly rents to foreigners .

101.2

Our discussion of trade integration in section 100 noted that
in a world of "second best" conditions, free trade is not necessarily
optimal. Where there are non-competitive elements we are in a
second-best world. Similarly, our discussion of the terms-of-trade
effect of tariffs (section 70) and the case in section 14 illustrated
the possibility of a country gaining by exploiting another country
as a monopsonist or monopolist. Thus, it is possible that free trade
is not optimal when there are increasing returns to scale and that
a strategic trade policy (tariff, subsidy, quota, etc.) may be better
for the imposing country than free trade.

A substantial amount of effort in international trade theory has
gone into modeling these notions. As yet, it is difficult to point
to handy rules-of-thumb that would tell a country what policy is best.
And policies imposed may be offset by retaliation from other countries
Thus, international trade economists still tend to favor free trade
on pragmatic grounds. They argue that because it is hard in practice
to know whether a strategic trade policy will help or hurt, and because
retaliation may occur, it is better not to embark on strategic trade
policies at all. But there are many who argue for selective government
interventions along lines outlined above. These issues will not be
resolved definitively, but there are benefits to be had from
accumulating case study evidence relating to the results of
particular attempts at strategic trade policy.